chapter 8 variance analysis: calculations...2018/11/02 · p1 – management accounting ch8 –...

P1 – Management Accounting CH8 – Variance analysis: calculations

Chapter 8 Variance analysis: calculations Chapter learning objectives:

Lead Component Indicative syllabus content

A.1 Discuss costing methods and their results.

(c) Apply standard costing methods including the reconciliation of budgeted and actual profit margins, distinguishing between planning and operational variances.

• Manufacturing standards for material, labour, variable overhead and fixed overhead.

• Standards and variances in service industries, public services (e.g. health and law enforcement), and the professions (e.g. labour mix variances in consultancies).

• Price/rate and usage/efficiency variances for materials, labour and variable overhead.

• Subdivision of total usage/efficiency variances into mix and yield variances.

• Note: The calculation of mix variances on both individual and average valuation bases is required.

• Fixed overhead expenditure and volume variances.

• Subdivision of the fixed overhead volume variance into capacity and efficiency variances.

• Sales price and sales volume variances (calculation of the latter on a unit basis related to revenue, gross profit and contribution).

• Sales mix and sales quantity variances. Application of these variances to all sectors including professional services and retail.

• Planning and operational variances.

• Variance analysis in an activity-based costing system.


1. Standard costing and variance analysis A standard is a benchmark measurement of resource usage or revenue or profit generation, set in defined conditions. (CIMA terminology)

Variance analysis is defined as the evaluation of performance by means of variances, whose timely reporting should maximise the opportunity for managerial action. (CIMA terminology)

• Standard costs - estimates of unit costs are made prior to actually incurring the cost.

• Actual costs are measured against these standard costs.

• The differences between the two are called variances.

• This process of comparison of different cost elements is called variance analysis.

• The cost and sales variance together explain any profit variance.

• When actual results are better than standard, we say it’s a favourable (F) variance.

• When actual results are worse than standard, we say it’s an adverse (A) variance.

Types of standards


• Variances can be calculated for costs and for sales.

Cost variances analyse the difference between actual costs and standard costs.

Sales variances analyse the difference between actual and budgeted sales prices and sales volumes.

Budgetary control • Concerned with total costs as opposed to the per unit standards in variance analysis.

• Does not consider the efficiency or inefficiency of costs incurred as in variance analysis.

• The budgetary system is a reporting system.

• Budgets are more frequently used for items such as marketing expenditure, research, etc.

Standard cost card • The standard cost card shows the standard costs / prices and usage / efficiency rates

that are expected to produce one unit of a product. Any deviations from these expected rates will result in variances.

Example: Standard cost card for Product X

£ per unit

Sales price 100

Materials (3 kg @ £15/kg) 45

Labour (2 hrs @ £3/hr) 6

Variable OH (2 hrs @ £5/hr) 10

Fixed OH (1 hr @ £10/hr) 10

Standard cost of production 71

Standard profit per unit 29


3. Sales variances Sales variance includes analysing:

• Actual sales price with the standard sale price, and

• Actual sales volume with the budgeted sales volume.

Sales price variance Sales price variance shows the effect on profit of a change in revenue caused by the actual selling price differing from that budgeted. (CIMA terminology)

• If the actual sales revenue is higher, it is a favourable variance.

• If the actual sales revenue is lower, then it is an adverse variance.

Sales price variance

Actual units x standard price/unit X

Less Actual units x actual price/unit (Y)

(X – Y)

(A negative value is a favourable variance)

Sales volume variance Sales volume variance is the measure of the effect on contribution/profit of not achieving the budgeted volume of sales. (CIMA terminology)

• The difference in units can be valued at standard cost or contribution or at standard revenue per unit.

Sales volume variance

Actual sales volume X

Less Budgeted sales volume (Y)

X – Y


Test Your Understanding 1 – Sales variances Xmas Ltd has budgeted sales of 500 units at $30 per unit. The variable costs are expected to be $20 per unit and there are no fixed costs.

The actual sales were 700 units at $25 per unit and the costs were as expected.

Calculate the selling price variance and the sales volume contribution variance.

$ F/A

Selling price variance

Sales volume contribution variance


4. Direct Material Variances

Direct material total variance Direct material total variance is defined as the measurement of the difference between the standard material cost of the output produced and the material cost incurred. (CIMA terminology)

• Viewed alone, it does not have much significance.

• A negative variance would be an adverse variance.

•

Direct material total variance

Actual quantity x standard cost/unit X

Less Actual quantity x actual cost/unit (Y)

Total variance (X – Y)


Direct material usage variance • The variance is valued at standard cost per unit.

Direct material usage variance

Actual output x standard quantity per unit X

Less Actual output x actual quantity per unit

Y

Direct material usage variance (units) X –Y

x per unit standard price P

Direct material usage variance (value) P(X – Y)

Direct material price variance


Actual quantity x standard price/unit X

Less Actual quantity x actual price/unit Y

(X – Y)

Test Your Understanding 2 – Direct material variances Jones Ltd makes a single product with the following budgeted material cost per unit:

• 5 kg of material A at $10 per kg

• Actual details are as follows:

o Output 1,500 units

o Material purchased and used 2,500 kg

o Material cost $60,000

Calculate the following variances and indicate whether they are favourable or adverse

$ F/A

Direct material total cost variance


Direct material usage variance


5. Direct labour cost variance

Direct labour total variance

Standard hours x standard rate/hr X

Less Actual hours x actual rate/hr Y

(X – Y)

Direct labour rate variance

Actual hours x standard rate X

Less Actual hours x actual rate Y

(X – Y)

Direct labour efficiency variance

Standard hours x standard rate X

Less Actual hours x standard rate Y

(X – Y)


Test Your Understanding 3 – Direct labour cost variances Mashup Ltd makes a single product and has the following budgeted/standard information:

Budgeted production 1,000 units

Labour hours per unit 2 hours

Labour rate per hour $10 per hour

Actual details:

Output 1,500 units

Hours paid and worked 3,500 hours

Labour cost $30,000

What will be the labour rate variance? A. 5,000 A

B. 5,000 F

C. 10,000 F

D. 10,000 A

What will be the labour efficiency variance?

A. $5,000 A

B. $5,000 F

C. $10,000 A

D. $10,000 F


6. Variable overhead variances

• Variable overheads are usually assumed to vary with direct labour hours.

• Therefore, direct labour hours are used for these variance calculations as well.

• In the service industry, only the total variable overhead variance is calculated.

Variable overhead total variance

Standard hours (for actual production) x standard rate X


(X – Y)

• In the production industry, the total variable overhead variance can be analysed as:

Variable overhead expenditure variance

Actual hours x standard rate X


(X – Y)


Variable overhead efficiency variance

Actual output x standard hrs/unit X

Less Actual output x actual hrs/unit Y

Efficiency variance (hrs) (X – Y)

x Standard variable overhead rate/hr R

Efficiency variance (value) R(X – Y)

Test Your Understanding 4 – Variable OH variances The budgeted output for Company A was 5,000 units of a key product. Each unit requires 3 direct labour hours, and variable overheads are budgeted at $2 per hour.

Actual results were:

Output 4,500 units

Labour hours worked 15,000 hours

Variable overheads $6,000

What is the variable overhead efficiency variance? A. $5,000 A

B. $3,000 F

C. $3,000 A

D. $5,000 F

7. Fixed overhead cost variance • Fixed overhead total variance is the difference between the actual fixed overheads

incurred and the standard fixed overheads absorbed into actual production using the standard absorption rate.

• Fixed overhead total variance is the over/under-absorption of overheads.

• Over-absorption gives a favourable variance; under-absorption gives an adverse one.


Fixed overhead total variance

Actual output x standard fixed overhead absorption rate X

Less Actual fixed overheads incurred Y

(X – Y)

Fixed overhead expenditure variance

Budgeted fixed overheads X

Less Actual fixed overheads Y

(X – Y)

Fixed overhead volume variance

Actual output X

Less Budgeted output Y

Variance (units) (X – Y)

x standard absorption rate R

Variance (value) R(X – Y)


Fixed overhead capacity variance

Actual hours x absorption rate X

Less budgeted expenditure Y

(X – Y)

Fixed overhead efficiency variance

Standard hours for actual output x absorption rate X

Less actual hours x absorption rate Y

(X – Y)

Test Your Understanding 5 – Fixed OH variances The following information relates to the fixed production overhead costs of a product, A:

Budgeted fixed production overhead expenditure $10,000

Budgeted production volume 5,000 units

Standard fixed production overhead cost:

(1 hour @ $4 per hour) $4

Actual units produced 6,000 units

Actual fixed production overhead expenditure $15,000

What will be the fixed production overhead expenditure variance and volume variance?

$ F/A

Fixed production overhead expenditure variance

Fixed overhead volume variance

Idle time and idle time variances • Idle time occurs when the workforce is not doing any work at all.

• If idle time occurs, we should split the efficiency variance into:

o Idle time variance

o Efficiency variance during active working hours

• Idle time variance is always adverse (it represents money wasted).


8. Operating statement • This is a variance report that reconciles the budgeted profit with the actual profit.

• It shows how all the variances affect the budgeted profit, changing it into the actual profit earned.

• Variance reports are prepared for every period, which may be monthly, fortnightly, weekly, etc., as per the management’s set time period.

• Reports should be duly provided to the relevant managers to prevent the data from becoming out-dated.

• The following proforma statement shows assumed figures.

Operating Statement for Period X

£ £ £

Budgeted gross profit 200,000

Sales volume profit variance 30,000 F

Budgeted profit from actual sales volume 230,000

Sales price variance 42,500F

272,500

Cost variances Adverse Favourable

Direct material X Price

Usage 5,100

15,000

Direct material Y Price

Usage

3,000 7,500

Direct labour Price

Efficiency Idle time

7,000

14,500 2,500

Variable overhead Efficiency

Expenditure 6,900

4,200

Fixed production overhead

Expenditure Volume

42,000

12,500

54,000 66,200 12,200F

Actual gross profit 284,700


9. Solutions to Test Your Understanding questions

Test Your Understanding 1 – Sales variances $ F/A

Selling price variance 3,500 A

Sales volume contribution variance 2,000 F

Selling price variance $

Actual sales units × standard price

700 units × $30 per unit 21,000

Actual sales revenue 700 units × $25 per unit 17,500

Selling price variance 3,500 (A)

Test Your Understanding 2 – Direct material variances $ F/A

Direct material total cost variance 15,000 F

Direct material price variance 35,000 A

Direct material usage variance 50,000 F

Direct material total variance $

Actual output should cost 1,500 units @ 5kg @ $10 per kg 75,000

Actual output did cost 60,000

Variance 15,000 (F)

Sales volume contribution variance $

Standard sales volume 500

Actual sales volume 700

Variance 200 (F)

× @ standard contribution per unit ($30 - $20) per unit $10 per unit $2,000 F


Direct material price variance $

Material A should cost 2,500 kg should cost $10 per kg 25,000

Did cost 60,000

Variance 35,000 (A)

Direct material usage variance kg $

1,500 units should use 1,500 units @ 5 kg 7,500

1,500 units did used 2,500

5,000 (F)

@ standard rate per kg @ 10 per kg 50,000 (F)

Test Your Understanding 3 – Direct labour cost variances Correct option: B

Labour rate variance

3,500 hours should cost 3,500 hours @ $10 per hour 35,000

3,500 did cost 30,000

Variance 5,000 F

Correct option: A

Labour efficiency variance

1,500 units should use 2 hours per unit 3,000 hours

1,500 units did use 3,500 hours

Variance 500 hours (A)

At $10 per hour $5,000 (A)


Test Your Understanding 4 – Variable OH variances Correct option: C

Variable overhead efficiency variance

Actual output at standard hours 4,500 hours @ $3 per hour 13,500 hours

Did take 15,000 hours

1,500 hours (A)

@ standard variable overhead rate per hour @ $2 per hour $3,000 A

Test Your Understanding 5 – Fixed OH variances $ F/A

Fixed production overhead expenditure variance 5,000 A

Fixed overhead volume variance 4,000 F

Fixed production overhead expenditure variance $

Budgeted fixed overheads 10,000

Actual fixed overheads incurred 15,000

Variance 5,000 (A)

Fixed production overhead volume variance Units $

Actual output produced 6,000

Budgeted output 5,000

Volume variance in units 1,000 (F)

@ standard fixed overhead rate per unit $4 per unit 4,000 (F)


10. Chapter summary

chapter 8 variance analysis: calculations...2018/11/02 · p1 – management accounting ch8 –...

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